The Capital Account and Pakistani Rupee Convertibility

Abstract

Pakistan embarked on the liberalization of its capital account more than two decades ago. Today, it is an economy with a capital account that is, by and large, free of restrictions, and a convertible currency. However, its actual integration into the global economy in comparison to other emerging market economies has remained rather limited. The opening of a capital account appeared to have improved the country’s access to private foreign capital, but because of domestic security and economic and political concerns, the inflow of private capital has fallen in recent years. Although capital outflows were not a major cause for the decline in foreign exchange reserves during Pakistan’s economic crisis of 2008, the open capital account and rupee convertibility have made it more vulnerable to outside shocks. This article identifies three areas where policymakers in Pakistan face serious challenges, i.e., macroeconomic management; controlling tax evasion, which the Pakistani rupee’s convertibility has made easier; and minimizing the real cost of portfolio investment to the country. The article offers ideas on how these challenges could be met.